|
| Losing the Public’s Trust: Third-Party Service Providers and Disclosure By Richard G. Brody, John M. Coulter, and John Jewell SEPTEMBER 2006 - While many of the high-profile corporate failures (e.g., Enron and WorldCom) have been associated with the large public accounting firms involved, other changes have also occurred beyond the view of the general public. Calls for increased transparency and concerns about ethical behavior have led to increased regulation over the financial reporting process, with the profession having lost a great deal of its credibility for self-regulation.The role of the AICPA changed with the passage of the Sarbanes-Oxley Act (SOX) in 2002. Now, the Public Company Accounting Oversight Board (PCAOB) oversees accounting firms with respect to services performed for publicly-held corporations. While the AICPA still maintains its regulatory role for nonpublic company audits, its previously issued standards are being superseded as the PCAOB issues its own. In recent years,
there has been an increasing trend toward the outsourcing of services
through third-party service providers in many industries, including public
accounting. Such outsourcing offers Ethics Rulings One area where the AICPA continues to play a major role is in advising its members when ethical issues arise. The AICPA’s Professional Ethics Executive Committee (PEEC) issues Technical Ethics Rulings on significant issues. AICPA members can also submit questions that are specific to their situation and receive guidance from the Professional Ethics Division. On October 28, 2004, the PEEC approved two new rulings and a revision to one existing ruling (respectively, Ethics Ruling 112 under Rule 102–Integrity and Objectivity; Ethics Ruling 12 under Rule 202–Compliance with Standards; and Ethics Ruling 1 under Rule 301—Confidential Client Information) that were, in part, intended to mitigate concerns regarding the credibility and confidentiality of client information in an outsourcing arrangement. In Ethics Ruling 112 under AICPA Code of Conduct Rule 102, in response to a question regarding mandatory disclosure to a client of the use of a third-party provider, the PEEC stated: “Accordingly, before disclosing confidential client information to a third-party service provider, a member should inform the client, preferably in writing, that the member may use a third-party service provider.” While one this ruling seems to “settle the issue,” important uncertainties remain regarding its interpretation and implementation. Of particular concern is the use of the word “should” as opposed to “must.” Furthermore, it is not clear that a client may truly understand what is being agreed to if the outsourcing disclosure is vague, is made only verbally, or is buried among legal and other disclaimers. Also at issue is whether a client is apt to view overseas outsourcing of information as being different in kind or magnitude from the simple use of a third-party service provider, and whether the disclosure to a client, if made, must indicate the location of the third-party service provider. In light of these lingering issues, it is fair to ask whether the AICPA adequately addressed the overall disclosure issue as it relates to outsourcing, and whether the recent ethics rulings were in the best interest of the accounting profession. Preparation of Outsourced Income Tax Returns Others (for example, see “Outsourcing Income Tax Returns to India: Legal, Ethical, and Professional Issues,” by Richard G. Brody, Mary J. Miller, and Michael J. Rolleri, in the December 2004 issue of the CPA Journal) have focused on the process of outsourcing income tax return preparation. In summary, a client’s tax information is sent via a secure server to India for processing. The completed information is then sent back to the United States for review and delivery to the client. Because of the time differential, work done in India can be ready the next morning. To help maintain security, the server containing the client’s information is maintained in the United States. Questions still remain regarding the mechanics of outsourcing, the safety of information (including issues related to the Gramm-Leach Bliley Act, which requires firms to protect clients’ privacy), the potential for the information to be compromised, and the views of the malpractice insurers. The Profession and the AICPA Many AICPA members were uncertain how much information had to be disclosed to clients regarding the outsourcing of their income tax return preparation to India. After all, in the end, a CPA is ultimately responsible for the tax return and provides a review of the return before signing off. But outsourcing companies have suggested that clients do not need to be specifically told; that is, a blanket disclosure could be used, or a general comment about the potential use of third-party providers would suffice as permission. The real issue is that tax preparers are not required to indicate specifically that a tax return would be sent to India. Setting aside the security issues, the focus should be on the ethical nature of this process. Public accounting firms often claim their clients do not care about the outsourcing issue. If so, then why not tell them directly that their return is going to be processed outside of their offices and, more specifically, sent to India? One potential concern is that this could lead to a request for reduced fees (because outsourcing generates greater profits), but this could, perhaps, be mitigated by assurances from the CPA that the return will be checked and signed by the CPA. Additionally, other industries make use of outsourcing, and there have not been widespread calls for service-charge reductions in those industries. The Birth of a Technical Ruling The tone of the introduction and background section of the exposure draft of the AICPA’s Technical Ethics Rulings in August 2004 was fairly narrow in scope; it centered on whether use of a third-party provider was a “release of confidential client information,” and not on the fairness or desirability of transparency in the required disclosure itself (aicpa.org/members/div/ethics/ed_outsourcing.htm). Thus, a generic disclosure with some mention that a third party was being used formed the basis of the proposed ruling. Many comment letters received by the AICPA called for stricter disclosure of whatever outsourcing was occurring. Some letters suggested the banning of overseas outsourcing. The final rulings, however, did not require specific disclosure of outsourcing, and indeed, the PEEC noted that they “believed it was appropriate to focus on the ethical issues when a member uses the services of a third-party provider and not (to) address the geopolitical concerns associated with outsourcing.” Thus, the ruling merely called for disclosure in some general sense (“preferably in writing”). Apparently lost in the rationale of the above explanation is that the geopolitical concerns themselves have ethical implications. Thus, the public accounting profession attempted to regulate itself through what it perceived to be adequate disclosure to clients with respect to the outsourcing of returns. In December 2005, however, the IRS issued a proposed regulation that would significantly strengthen the disclosure requirement when the third-party provider was in a foreign country. It would specifically require the taxpayer’s prior written consent before return preparation could be outsourced overseas. While the regulations are not finalized, it is safe to assume that once again the profession’s attempts at self-regulation will be superseded by the federal government, much as the PCAOB regulates the auditors of public companies. Survey Results To gather evidence on taxpayers’ perceptions concerning public accountants’ disclosure of tax return preparation outsourcing, a convenience sample (where participants were selected at the convenience of the researchers and no attempt was made to ensure that the sample was an accurate representation of the entire population) was taken of 345 taxpayers in a major city in the southeastern United States. As with any convenience sample, there is always the issue of the ability to generalize the results beyond the actual sample. The size of the sample was fairly large, however, and there was no bias in the data-collection process. The authors believe the survey results still provide some fairly significant insights into the issues, and the subjects provided consistent responses that the authors suspect would be obtained by a larger or random sample. Each subject was asked six questions regarding outsourcing and its disclosure. Responses to Question
1 indicate that approximately 60% of those surveyed use a paid tax return
preparer, consistent with the 56% figure noted in a recent GAO report
(http://www.senate.gov/~finance/ An interpretation of the responses to Question 2 underscores an important fundamental issue: In an environment of purportedly mandated disclosure, do individuals know when their tax preparers are outsourcing the preparation of tax returns? Only 6.2% of respondents who use a paid preparer indicated that they know that their returns are outsourced, while 45% said that they did not know. The second fundamental issue is addressed by Question 3. The results indicate that approximately 72% who use a paid preparer do care if their return is outsourced. Questions 4 and 5 provide further evidence of the significant concerns taxpayers have. More than 84% of respondents who use a paid preparer said that it would make a difference to them if their preparer outsourced a return overseas, and more than 90% said that they were not aware that their preparer is not obligated to inform them if the preparation of a return is going to be outsourced. Question 6, perhaps the most important issue, shows that a huge percentage of respondents (80.8%) who use a paid preparer said that the failure of their tax preparer to inform them that their return had been outsourced would affect their perception of the preparer’s trustworthiness. As indicated in Exhibit 2, the results of respondents who do not use a paid preparer were similar to the responses for those who do. Specifically, in response to Question 3, approximately 73% of these respondents indicated that they would care if their accountant outsourced the preparation of their return. This was not a statistically significant difference from the responses of those who use a paid preparer. Regarding Question 4, almost 88% of those who do not use a paid preparer stated that it would make a difference if their return was outsourced overseas. This response was also not statistically significantly different from those respondents who use a paid preparer. There was a significant difference between the two groups with respect to their awareness of whether a preparer is required to inform a client about outsourcing (Question 5). Despite this difference, there is no apparent practical significance associated with this result and it has no bearing on the overall results. In the end, 83% and 90%—both overwhelming majorities—were still not aware that disclosure of outsourcing was not required. Differences in the response to Question 6 were only marginally significant, with those not using a paid preparer being slightly more likely to say that failure to disclose outsourcing would affect their perception of the trustworthiness of their provider (86.8% versus 80.8%). Overall, it is clear that the respondents share similar views, regardless of whether or not they use a paid preparer. Additionally, the data obtained strongly suggest that preparers who do not adequately disclose information are negatively perceived by taxpayers. Comment Letter Responses Before the AICPA issues its technical rulings, an exposure draft is issued and AICPA members are able to respond with comment letters. An exposure draft was issued on August 9, 2004 (Omnibus Proposal of Professional Ethics Division Interpretations and Rulings), and less than five of the 48 responses were in support of the exposure draft. The overwhelming majority of the comment letters received voiced concern about the proposed ethics rules (see Exhibit 3, Panel A). Even the majority of the “positive” responses (see Exhibit 3, Panel B) did not completely support the exposure draft, primarily because the draft did not mandate disclosure. While some comments addressed the issue of foreign outsourcing as a primary problem, others emphasized the importance of complete and full disclosure and wanted to make disclosure to clients mandatory. Given that the final wording said that a tax preparer “should”—not “must”—disclose the use of a third-party service provider, many have been left frustrated, disappointed, and, sadly, worried about clients’ reactions when they discover this practice. Both the comment letters received by the AICPA and the results of this survey clearly indicate that people care passionately about this issue. While one concern is related to the security and privacy of confidential information, a bigger concern may be disclosure. Individuals want to know if their information is not being processed by the person they are paying, and if their information is being sent outside the country. The authors believe this was a known problem, and the AICPA consciously made a decision that many find to be inadequate and not in the best interest of the profession. Implications The AICPA had another chance to do the right thing, but despite the objections received in many of the comment letters, the final ruling was “soft.” It did not state that clients had to be informed in writing that their information might be provided to third-party providers. It also did not state that clients had to be told that their information might be sent to India. This issue has not been widely disseminated among the general public, and many AICPA members are not familiar with it. As awareness grows, however, one must wonder if this decision by the AICPA will further tarnish the reputation of the accounting profession. The AICPA still retains some power with respect to the profession, but this lack of forthrightness may do further harm to its reputation. To quote an individual responding to the exposure draft:
Richard G. Brody, CPA, CFE, is an associate professor of accounting at the Robert O. Anderson Schools of Management at the University of New Mexico, Albuquerque, N.M.; John M. Coulter is an associate professor at the school of business at Western New England College, Springfield, Mass.; and John Jewell, CPA, JD, LLM, is an instructor of accounting and law at the University of South Florida, St. Petersburg, Fla. |
Print